Saturday, April 16, 2005
Book value - for accounting geeks
Here's a nit about the financial definitions list.
"Book value" is NOT "The value of a company's assets,
if they were sold tomorrow."
Book value is an accounting figure that does attempt to
reflect the reality that assets dwindle in value with
time. But it does not attempt to appraise assets at
fair market value, which could be constantly
changing.
Say a company buys a forklift truck for $25,000 (I'm
making up these numbers -- I have no idea how much
forklift trucks cost these days).
Its book value for the first year is $25,000.
Every year thereafter, the accountanting department
must reduce the book value due to depreciation.
The forklift is not getting any newer.
The exact process is governed by the law and generally
accepted accounting principles.
Maybe they assume the forklift truck will last
for 10 years and use straightline depreciation
(to keep this example simple).
So every year they reduce its book value by $2500
(1/10 of the initial price).
Companies are NOT required to get an appraisal of
fair market value for that brand and age and
condition of forklift trucks every year. That
would be prohibitively expensive to do for every
single piece of equipment they own and for heavy
machinery not truly accurate anyway.
At the end of 10 years, that forklift, if well
maintained and escaping any accidents, might
be almost as valuable in terms of the company's
actual business as it was when brand new.
That is, it still lifts heavy objects and moves
them from one place to the other.
And it might now cost $40,000 to replace if that were
necessary.
Where I often see book value mentioned in
financial promotions is comparing total book
value of the company to the overall
market capitalization of the company.
If stock price is close to book value, that
tends to indicate that it is low -- because a
company SHOULD be worth more IN TOTALITY -- as
a functioning business -- than the sum of
its book values. As a business making and marketing
products for profit, it should be worth a lot more
as an operational entity than as a pile of assets sold
off in an auction.
If it's not, something is wrong either with
its business or its stock price. And it could
also be the subject of a hostile takeover. That
was the basis of the 1980s Oliver Stone
movie WALL STREET.
The mean, ruthless corporate raider Gecko targeted the
company in the movie because he could buy it up and
then sell off its component pieces and get more than he
paid for all the shares of stock.
more copywriters
"Book value" is NOT "The value of a company's assets,
if they were sold tomorrow."
Book value is an accounting figure that does attempt to
reflect the reality that assets dwindle in value with
time. But it does not attempt to appraise assets at
fair market value, which could be constantly
changing.
Say a company buys a forklift truck for $25,000 (I'm
making up these numbers -- I have no idea how much
forklift trucks cost these days).
Its book value for the first year is $25,000.
Every year thereafter, the accountanting department
must reduce the book value due to depreciation.
The forklift is not getting any newer.
The exact process is governed by the law and generally
accepted accounting principles.
Maybe they assume the forklift truck will last
for 10 years and use straightline depreciation
(to keep this example simple).
So every year they reduce its book value by $2500
(1/10 of the initial price).
Companies are NOT required to get an appraisal of
fair market value for that brand and age and
condition of forklift trucks every year. That
would be prohibitively expensive to do for every
single piece of equipment they own and for heavy
machinery not truly accurate anyway.
At the end of 10 years, that forklift, if well
maintained and escaping any accidents, might
be almost as valuable in terms of the company's
actual business as it was when brand new.
That is, it still lifts heavy objects and moves
them from one place to the other.
And it might now cost $40,000 to replace if that were
necessary.
Where I often see book value mentioned in
financial promotions is comparing total book
value of the company to the overall
market capitalization of the company.
If stock price is close to book value, that
tends to indicate that it is low -- because a
company SHOULD be worth more IN TOTALITY -- as
a functioning business -- than the sum of
its book values. As a business making and marketing
products for profit, it should be worth a lot more
as an operational entity than as a pile of assets sold
off in an auction.
If it's not, something is wrong either with
its business or its stock price. And it could
also be the subject of a hostile takeover. That
was the basis of the 1980s Oliver Stone
movie WALL STREET.
The mean, ruthless corporate raider Gecko targeted the
company in the movie because he could buy it up and
then sell off its component pieces and get more than he
paid for all the shares of stock.
more copywriters
